Deduction for Gratuity Contributions to LIC Without a Trust: Legal Analysis under Sections 36(1)(v), 40A(7), and 43B of the Income-tax Act, 1961

Introduction

Employee welfare is a cornerstone of corporate responsibility, and gratuity forms a critical part of the social security benefits provided by employers. For private limited companies, one common question is whether contributions made directly to the Life Insurance Corporation of India (LIC) under its Group Gratuity Scheme—without creating a separate gratuity trust—qualify for deduction under the Income-tax Act, 1961. This issue primarily revolves around the interplay of Section 36(1)(v), Section 40A(7), and Section 43B.

This article examines statutory provisions, relevant case laws, CBDT circulars, and judicial interpretation to clarify the deductibility of such payments.

 

Statutory Framework

 

1. Section 36(1)(v)
• Allows deduction for contributions to an approved gratuity fund created under an irrevocable trust for the exclusive benefit of employees.
• Key conditions: (i) irrevocable trust, (ii) approval under Part C of the Fourth Schedule, (iii) employer cannot exercise control over the fund.
2. Section 40A(7)
• Restricts deduction for gratuity provisions.
• Deduction is allowed only if:
• (a) it is for an approved gratuity fund, or
• (b) the provision relates to gratuity that has become payable during the year.
3. Section 43B(b)
• Overrides other provisions.
• Deduction for contributions to gratuity, provident, or superannuation funds is permitted only on actual payment, regardless of the method of accounting.

 

Issues Faced by Companies Without a Trust

 

Private companies often prefer paying contributions directly to LIC under its Group Gratuity Scheme, bypassing the complexity of setting up and managing an independent gratuity trust. However, this raises concerns:

• Does such a payment satisfy the “approved gratuity fund” requirement under Section 36(1)(v)?
• Can it be allowed under Section 43B even without formal trust approval?
• Is the deduction disallowed under Section 40A(7) if no trust exists?

 

 

Judicial Precedents

1. CIT v. Textool Co. Ltd. (Supreme Court, 2013)

• Facts: Employer paid directly to LIC towards Group Gratuity Scheme.
• Held: Deduction allowed. Once paid to LIC and employer lost control, the condition of irrevocable transfer was satisfied.
• Principle: Substance prevails over form—direct contribution to LIC scheme suffices where employer has no control over funds.

2. Andaman & Nicobar State Co-operative Bank v. DCIT (ITAT Kolkata, AY 2014–15)

• Deduction allowed for LIC group gratuity payments.
• Emphasized that employer lost control once funds were transferred.

3. Allahabad High Court (ITA No. 12 of 2015)

• Held that payment to LIC under group gratuity scheme qualifies as contribution to an approved gratuity fund in substance.

4. CIT v. Jaipur Thar Gramin Bank (Rajasthan HC, 2017)

• Even where approval of gratuity fund was pending, deduction allowed since the payment was exclusively for employees and beyond employer’s control.

5. Narasu’s Spinning Mills v. ACIT (ITAT Chennai, 2016)

• Deduction permitted for LIC group gratuity contribution, despite pending approval, provided funds were irrevocably transferred.

 

CBDT Rules and Circulars

• Rule 101 of the Income-tax Rules, 1962 permits gratuity funds to invest in LIC’s Group Gratuity Scheme. This implicitly recognizes LIC schemes as acceptable vehicles for gratuity management.
• No recent CBDT circular (2024–25) directly addresses deduction without a trust, but departmental practice often follows judicial interpretation.

 

Interplay of Sections 36(1)(v), 40A(7), and 43B

 

1. Section 36(1)(v) requires an approved gratuity fund. Technically, payment without an irrevocable trust may not qualify strictly under this clause.
2. Section 40A(7) disallows mere provisions unless related to an approved fund or gratuity payable in the year. Thus, provision without payment is not deductible.
3. Section 43B(b), however, allows deduction on actual payment. Courts have consistently read this provision liberally to permit deductions for payments to LIC group gratuity schemes, even where a formal trust is absent, provided:
• Payment is irrevocable,
• Employer has no control,
• Funds are exclusively for employees.

 

 

Practical Guidance for Companies

• Deduction Allowed: If payment is made directly to LIC under the Group Gratuity Scheme, deduction is generally available under Section 43B.
• Documentation: Maintain records of LIC policy, payment vouchers, and terms showing employer’s lack of control.
• Safer Route: Setting up an irrevocable gratuity trust and seeking approval under Part C of the Fourth Schedule ensures seamless compliance.
• Timing of Payment: Deduction available only in the year of actual payment (or if paid before the due date for filing return under Section 139(1)).

 

Risks and Litigation Issues

 

• Assessing Officers may disallow deduction citing lack of approved trust.
• Appeals may be necessary, relying on Textool (SC) and subsequent ITAT/HC judgments.
• Pending approval of gratuity fund has been held not to bar deduction, but litigation risk remains.

 

Conclusion

 

For a private limited company contributing directly to LIC under its Group Gratuity Scheme without creating a separate trust, deduction under the Income-tax Act is possible, but it hinges on actual payment (Section 43B) and judicial interpretations. The Supreme Court in Textool and subsequent rulings have established that such contributions are deductible provided the employer irrevocably parts with the money and has no control over its use.

While technically Section 36(1)(v) requires an approved gratuity fund, judicial precedents treat LIC-managed schemes as sufficient in substance. However, for risk-free compliance, creating an irrevocable trust and obtaining approval remains the most robust approach.

In summary:

• Yes, deduction is allowable on actual payment to LIC’s group gratuity scheme even without a gratuity trust, under Section 43B.
• Reliance may be placed on CIT v. Textool Co. Ltd. (SC) and other ITAT/HC decisions.
• To minimize disputes, companies should document irrevocability and employee exclusivity, and ideally consider creating an approved gratuity trust for long-term compliance.